Captive owners focus on employee benefits

Network fronting insurers estimate that roughly 100 of the over 6,800 captives in the world are writing employee benefits but Ms Stack believes there are many more writing coverages on a single line or on a single cession basis. "So the actual number of captives participating in employee benefit financing arrangements is far higher than conventional industry measurement suggests, and it's growing." The reason for the growth is clear. "The captive model is a natural fit for employee benefits," she explained. "For a multinational captive owner with headcount and premium spread over a number of countries, inserting the captive in financing arrangements can result in significant savings. The risk is a great fit for the captive also as employee benefit losses tend to be of a high frequency/low catastrophe nature. So, for instance where a captive owner, let's say an energy company, may experience volatility in property and casualty captive losses, introducing employee benefit risk can assist in smoothing the captive's overall loss cycle."hideHowever, it can take time for a captive to get involved with employee benefits. To begin with, Ms Stack pointed out, most companies start off in a decentralised state with plans negotiated locally all over the world, and the first step on the journey is to consolidate them, and that takes time, not least because some local plans may be on a two to three year basis. Typically, the path to a captive involves consolidating the plans into a number of pooling networks, and then placing a reinsurance cession back to the captive. "For a large multinational starting today with a fragmented programme and a lot of different local plans, it could take two to three years to consolidate and roll everything into a captive," she said. When it comes to employee benefits and captives, the US is more complicated than the rest of the world, she explained, largely because of the requirement in the US to seek Department of Labor approval to write employee benefits in a captive. The process is much easier outside the US, she said, so the rest of the world is moving more quickly, although US multinationals are putting their employee benefits risks outside of the US into captives as well. The momentum is also being driven not just by risk managers but by human resources managers as well. She said that increasingly risk managers are working together with benefits managers and looking at this together as a joint project. And, she added, where it works best is where there is a really good relationship between the two functions. Pension Captives The latest and most interesting development in this area involves captives in the defined benefit pension space, although only a small number of companies are doing this at the moment, said Ms Stack. While defined benefit pension plans are generally a thing of the past they can leave huge legacy issues on the balance sheet of many corporates who are seeking efficient methods of management. There is interest in captives being used to improve efficiencies, using two main structures, depending on motivation. The first is where a company's motivation is to gain financial and operational control over pension plans in different jurisdictions with differing governance. In this case, the local trustees purchase an investment, an annuity product, from a fronting insurer which is then reinsured to the captive. This structure is known as a buy-in and it gives the corporate the ability to get control over plans and indeed any surplus which might arise due to inevitable changes in investment strategy. The capital and resourcing requirements involved in this structure make it attractive to those with significant financial resources and operational will, said Ms Stack. The more common structure is where the motivation is about offsetting longevity risk. "There is a risk that employees will live longer than anticipated and that risk will sit with the trustees of the local plans," she said. "In order to manage the liability, they can enter into a longevity swap with a commercial insurer to insure that risk. The fronting insurers then typically reinsure into the reinsurance market, and it is the reinsurers who set the pricing. In this instance, captives can simply be used as a fronting vehicle to access the reinsurance market for longevity swaps." She said that it is the UK that is driving the momentum behind captive innovation in the longevity market, largely because the issue has crystallised there already. As a result, a number of UK schemes have established captive structures in Guernsey for this risk, and she expects to see further growth in this area.

Captive owners focus on employee benefits

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